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Energy and commodity price benchmarking and market insights

Crude Pricing and Indexation

Denver, Colorado

Gus Vasquez

18 June 2012

• Report prices in all world markets for
• Refined products
• Crude
• NGL & LPG
• Coal and coke
• Gas
• Power
• Fertilizers
• Emissions
• Over 400 staff globally with numerous offices
• Rapid growth in spot and term contract indexation,

swaps market indexation

Who is Argus?

• Argus is now a standard benchmark for trade in
• US

domestic and import crude oil

• US

gasoline, diesel, and j et fuel

• Argus reports the market the way that it trades and

believes liquidity and transparency lead to accuracy

• Argus prices for US

crude are volume-weighted averages of trades throughout the entire trading day

• Argus S
• ur Crude Index (AS

CI)

• Used to price both long-haul and short-haul foreign crudes
• Argus LLS
• Used to price Bakken and Eagle Ford

Why Argus?

• Provide representative, verifiable, and consistent

price discovery by monitoring arms-length market activity

• Consult with industry and wider stakeholders to

ensure appropriateness of methodologies

• Avoid a “ one size fits all” approach
• Where possible reflect existing market structures and

trading practices

• Argus believes liquidity and transparency lead to

accuracy

• Argus has a robust process for assessing market prices in the

absence of active trading

Argus approach to price discovery

• Daily volume weighted average of deals done
• Example: US

Gulf coast domestic crude pricing

• Differentials to WTI are averaged with volume weighting
• Differentials applied to Nymex settlement price
• Daily assessment of low/ high range
• Examples: Bakken Clearbrook, West African delivered US

GC

• Trade is too illiquid to use daily VWA
• All VWAs default to a low/ high range when liquidity is low

Basic methodologies

• Assessed bid/ ask range at a moment in time
• Forward curves
• Monthly weighted averages of deals done
• Example: WCS

Canada

• Based on monthly average pricing common in the market
• Calculated indices

Basic methodologies

• Differential price is volume-weighted average of all

deals over entire trading day

• All qualifying deals are counted regardless of volume
• Counterparties are validated and duplicates netted out
• Aggregate volume minimum must be met, or price defaults

to mean of low and high

• Differential averages are applied to Nymex

settlement price

• During 3 days after expiry, applied to WTI Cushing price,

which is a volume-weighted average of “ roll” trades, which are applied to the prompt month Nymex settlement price

Volume-weighted averages

Index pricing

• The spot market at the Gulf coast –

when all deals are considered – is deep and broad

• A ready well of deals exists for price formation even

if WTI-related transactions decline

• The use of LLS

and Mars as secondary benchmarks is growing and offers several possibilities to the marketplace

• Argus continues to monitor the Gulf coast market for signs of

foundational change

• Healthy indices lead to confidence in derivatives

markets

The spot markets are healthy

S pot trade activity

500,000 1,000,000 1,500,000 2,000,000 2,500,000 Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2010 2011 2012 Total b/d per month Eugene Island Poseidon Southern Green Canyon Bonito Thunder Horse WTI P-Plus HLS WTS WTI Midland Mars

One popular way to get to a final price is:

CMA (Nymex settles during delivery month) + Average diff to CMA based on settles during Nymex trade month (Argus diff t o CMA mont hly average) + Argus trade month average differential for crude grade +/ - Transportation and quality adj ustments

Contract pricing formulas

Price can also be calculated in the following way:

Average Nymex S ettles in Delivery Month + Argus Trade Month Average differential

Or price could j ust equal:

• The average of Argus Trade Month price (Argus outright prices)
• The average of Argus daily price during delivery month

Other pricing formulas in contracts

Another way to calculate price is:

Average Nymex S ettles in Nymex prompt month + Argus Trade Month Average differential

And finally:

Average daily WTI Posting during delivery month + Argus P+ trade month average + Argus Trade Month Average differential

Other pricing formulas in contracts

• Price = Average Nymex S

ettles in Delivery Month + Argus Trade Month Average differential + Quality differential - Transportation Costs

• Example:
• Nymex settles at $100/ bl + $12.50/ bl for LLS

+ $2 for Eagle Ford

• Eagle Ford price at a given location = $114.50/ bl
• Netback will be:
• Eagle Ford at $114.50/ bl - $10/ bl for transportation to S

t James

• Final Eagle Ford Price at the field = $104.50/bl

Calculating a netback value to the field

Value vs. price

Examples of refinery yields

Crudes by quality

WTS WTI LLS HLS Thunder Horse Bonito Eugene Island Poseidon Mars SGC Escravos Nemba Kissanje Basrah Light Oriente Maya ASCI 20.00 25.00 30.00 35.00 40.00 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 API Gravity Sulfur

• The goal of refining is to turn crude oil into higher

value products

• With necessary equipment, a complex refinery can

buy low value crude and turn into high value product

• Crude price is a function of
• Refinery demand (equipment in each refinery varies and

product slate changes seasonally)

• Current value of products
• Crude supply
• Transportation constraints

What does this have to do with price?

• Refinery outages
• Planned maintenance
• Unplanned outage
• S

easonality

• S

ummer is gasoline season

• Winter is about heating oil
• Refinery margins
• Margins determined by product and oil prices
• Weak margins may force refiners to cut runs
• Product export opportunities

Demand side factors affecting price

4-Week Avg US GC utilization of operable capacity

80 85 90 95 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 Jan 11 Feb 11 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 Jan 12 Feb 12 Mar 12 Apr 12 May 12 % age utilization

• Field or platform maintenance
• Transportation disruptions
• Pipeline issues
• Bottlenecks or new infrastructure coming on line
• Regional oversupply
• The Cushing disconnect
• Import fluctuations
• Increase or decrease in production
• Natural field decline
• New plays coming on

S upply side factors affecting price

Break in flow disrupts stream

Refiner pays more for

• ther options

Decreased Supply Increased Supply

Pipeline Break

US domestic production forecasts

0.5 1 1.5 2 2.5 3 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 million barrels per day Deepwater Gulf of Mexico US Shale Oil

Source: EIA

Waterborne sweet crude imports into US GC

Source: EIA

10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 '000 barrels

Net Loss: 1.015mn b/d supply 665,450 b/d: Feb 2012 1,680,000 b/d: Sep 2010

• A bottleneck at Cushing pushed WTI to discounts

against Brent beginning in 2007

• WTI has been unable to return to its historic premium
• ver Brent
• Persistent crude over-supply in the Chicago area

depressed WTI values as Cushing stocks rose

• Canadian crude inflows exacerbated supply

The WTI/ Brent inversion

• Once crude reached Cushing, it could previously only

move north to the Midwest or go into storage

• Now, with the S

eaway Pipeline reversal, crude can also move from Cushing to the US GC

• Pipeline was reversed around mid-May
• Initially moving 150,000 b/ d
• US

domestic differentials to WTI are constructed using:

• The Brent/ WTI spread
• The value relative to other domestic grades
• Increasingly, the value of grades versus LLS

and the value of LLS versus Brent

The WTI/ Brent inversion

LLS relationship to Brent and WTI

75 85 95 105 115 125 135 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 $/bl Brent LLS WTI

• WTI’s dislocation from Gulf coast increased the basis

risk embedded in Gulf coast differential

• Discouraged spot transactions versus WTI for Gulf

coast grades

• Encouraged increased trade against non-WTI pricing

references – especially at the Gulf coast

• The Argus methodology is currently a volume weighted

average only of deals done at a differential to WTI

• In illiquid markets, Argus will make an assessment based on
• ther information, such as conversion or box trades
• Encouraged growth in LLS

swaps transactions

WTI inversion effect on spot market liquidity

Mars differential to WTI

• 15.00
• 10.00
• 5.00

0.00 5.00 10.00 15.00 20.00 25.00 30.00 $/bl

LLS differential to WTI

• 5

5 10 15 20 25 30 35 $/bl

Ratio LLS

• WTI:Brent-WTI, 1:30 CS

T

60% 70% 80% 90% 100% 110% 120% 130% 140% Mar-11 Apr-11 May-11 May-11 Jun-11 Jul-11 Jul-11 Aug-11 Sep-11 Sep-11 Oct-11 Nov-11 Nov-11 Dec-11 Jan-12 Jan-12 Feb-12 Mar-12 Mar-12 Apr-12 May-12 May-12 Ratio LLS-WTI:Brent-WTI, 1:30 CST

S econdary benchmarks

• Diverse participants
• Active physical trade and transparency
• Flexible infrastructure
• Evergreen production lifespan
• Reacts to local fundamentals
• Reacts to global waterborne fundamentals
• Provide a stable value that differentials can be

predictably set against

• S

upported by a strong financial market with a sound regulatory structure

What makes a good benchmark?

• Light Louisiana S

weet is a blended stream

• Capline defines LLS

as any crude oil stream that has:

• Between 34-41°API
• S

ulfur content of no more than 0.40pc

• Total Acid Number (TAN) of no higher than 0.70
• Increasingly the blending of west African crudes into

LLS is being displaced by the blending of shale crude

• Bakken (arrives by rail) and Eagle Ford (arrives by barge)
• A strong supply profile going forward
• Because of its location and supply flexibility, LLS

price is well correlated to Atlantic basin crude prices

What is LLS ?

• LLS

is already used as a benchmark with US domestic light grades being discussed on an LLS basis

• Bakken
• Eagle Ford
• West Texas
• Foreign lights coming into US

Gulf coast have been

• ffered at an LLS
• related price
• Valero, Marathon and others use LLS

in financials to calculate product margins

• S

waps activity on LLS is rising sharply

• Open interest is 50%

higher than a year ago

The current role of LLS

• In general, any crude that arrives at S

t James can be blended to LLS

• specs. Economics determine the mix
• Domestic grades normally used:
• Any grade from US

GC production

• Bakken (arrives by rail) and Eagle Ford (arrives by barge)
• Foreign grades commonly used:
• Venezuelan (used as base and blended with condensate)
• West African
• S

aharan Blend

• Because LLS

is a blended grade, the forward supply profile is strong – unlike that for the North S ea

LLS Blending and S upply

LLS buyers and sellers

11.52% 11.48% 10.71% 9.43% 8.29% 6.46% 6.08% 4.80% 4.56% 3.80% 3.42% 3.42% 3.42% 2.66% 2.28% 1.14% 1.14%

LLS Sellers

15.23% 15.21% 12.24% 9.03% 8.78% 7.22% 5.70% 4.80% 4.11% 3.80% 2.66% 2.28% 1.14% 1.14% 1.03%

LLS Buyers

• Gulf coast buyers of Latin American crude are using

AS CI and/ or Argus Mars as the basis for their purchases

• US

domestic producers have signed deals on AS CI as a way of capturing generic Gulf coast sour values

• Also internal pricing purposes
• AS

CI can be used with an adj ustment factor to price term crude on either an fob or cif basis

• As a combination of three medium sour streams, AS

CI removes any concerns over hurricane disruption

• AS

CI has a proven three-year record

• Around 1.8mn b/ d of imported crude price on AS

CI

AS CI offers a robust alternative benchmark

AS CI buyers and sellers

16.35% 12.52% 11.70% 11.53% 9.01% 8.24% 4.36% 4.28% 4.16% 3.95% 2.97% 2.31% 2.31% 2.31% 1.32% 1.05%

ASCI Sellers

18.26% 17.01% 15.32% 7.91% 5.93% 4.28% 3.95% 3.41% 3.29% 2.97% 2.31% 2.31% 1.98% 1.65% 1.65% 1.32% 1.32% 1.32% 1.32%

ASCI Buyers

Infrastructure

• Production increases are currently outpacing the

ability to move barrels to market

• Current planned proj ects would provide greater take-

away capacity than total production

• Not all proposed proj ects will come to fruition
• Railing, trucking and barging are providing short to

medium term solutions

Overview of infrastructure issues

• Once pipeline proj ects are completed, crude

valuations and market dynamics will change

• Challenges remain for producers as finding buyers

becomes increasingly difficult

• Light sweet imports should continue to drop and

eventually even disappear altogether

Overview of infrastructure issues

Pipeline Expansions, New Builds and Reversals

S torage Expansions

Proj ects Completion S chedule

Cushing 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Seaway Reversal (Enterprise/Enbridge)* Mississippian Lime (Plains) OK Pipeline (SemGroup, Gavilon, Chesapeake JV) Flanagan (Enbridge) Keystone XL (TransCanada)** Bakken 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Bakken North (Plains) Bakken Expansion (Enbridge) High Prairie (Saddle Butte Pipeline) Bakken Marketlink (TransCanada) Eagle Ford 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Harvest EF Enterprise EF Phase I* Trafigura/Energy Transfer Partners NuStar/Valero EF KinderMorgan Crude & Condensate Project Plains Eagle Ford NuStar/TexStar Eagle Ford Koch Eagle Ford Enterprise EF Phase II West Texas 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Bone Spring (Plains) Basin Expansion (Plains) Permian Basin Norht & South Spraberry (Plains) West Texas Gulf (Sunoco) Longhorn Revesal (Magellan) Ho-Ho Reversal (Shell) Westward Ho (Shell) *Project has been completed **Pending regulatory approval

Capacity: 400,000 b/ d Route: Cushing, Oklahoma to Freeport, Texas Operational: June 2012

• Pipeline was reversed to take

crude to US GC

• Currently shipping 150,000 b/ d,

ramp up to 400,000 b/ d by 1Q13

• Includes lateral pipes to ECHO

terminal and from ECHO to Beaumont/ Port Arthur

• Twin line of 450,000 b/ d by 2014

Enterprise / Enbridge S eaway pipeline

Source: Enterprise

LLS differential to WTI

• 5

5 10 15 20 25 30 35 $/bl

Capacity: 830,000 b/ d Route: Hardisty, Alberta to Port Arthur, Texas Operational: early 2015

• Expected to ship 2/ 3 heavy

crude

• A bill was approved by Energy

Committee in early February. Pipeline permission process will continue.

• Companies committed to

380,000 b/ d through take-or- pay contracts from Canada to US GC

TransCanada Keystone XL Pipeline

Capacity: 585,000 b/ d Route: Flanagan, Illinois to Cushing, Oklahoma Operational: mid-2014

• Generally adj acent to

Enbridge’s S pearhead pipeline

• Initial open season Oct 2011
• A second binding open season

ended in February

• Capacity is fully contracted

except from mandatory 10pc required by federal regulators

Enbridge’s Flanagan S

• uth Pipeline Proj ect

Source: Enbridge

Conclusions

• Crude value and price diverge depending on market

fundamentals

• And price also varies from one region to another
• The relationship between similar crudes, competing

against each other for a limited amount of buyers in a given region, can determine price

• Benchmarking
• Quality differences can determine a grade’s value

relative to its competitors, all things being equal

Conclusions

• Transportation costs can make a crude uncompetitive

in certain regions but more attractive in others

• Contract pricing takes into account index pricing,

quality differences and transportation

• Quickly changing infrastructure and production levels

are adding uncertainty to the future of prices, especially for lighter grades

Conclusions

Any questions?

Gus Vasquez Americas Crude Editor gustavo.vasquez@ argusmedia.com Phone: 713-968-0014